Text version: Investing in unlisted debentures and unsecured notes

Introduction

Independent guide for investors reading a prospectus for
unlisted debentures or unsecured notes. This guide is for you,
whether you're an experienced investor or just starting out.

About ASIC

The Australian Securities and Investments Commission (ASIC)
regulates financial advice, financial products and company laws to
protect you. Our MoneySmart website for consumers and investors
offers you free and impartial tips and safety checks about the
financial products and services we regulate.

How can this booklet help you?

Read this booklet together with the prospectus and remember:

the return offered is not the only way to assess this
investment: make sure you understand the risks

the information in this booklet is general in nature. To work
out a detailed strategy that meets your individual needs, consider
seeking professional advice from a licensed financial adviser.
Visit ASIC's website for consumers and investors at
www.moneysmart.gov.au for more independent information from ASIC
about what to watch out for when investing

Key tips from ASIC about investing

Anything you put your money into should meet your goals and
suit you.

No one can guarantee the performance of any investment. You may
lose some or all of your money if something goes wrong.

The rate of return offered is not the only way to assess how
risky an investment is.

'High return means high risk' is a familiar rule of thumb. Some
investments, even if they seem to offer relatively moderate
returns, can be extremely risky.

Take your time and do your research before deciding what to
invest in. Visit ASIC's website for investors, MoneySmart, at
www.moneysmart.gov.au, for more information.

You are taking a big risk if you put all your money into one
investment. Spreading your money between different investment types
('diversification') reduces the risk of losing everything.

Consider seeking professional advice from a licensed financial
adviser.

'Listed' and 'unlisted' investments

This is one of two investor booklets that look at different
types of debt securities (investments). Separate booklets on other
unlisted investments-mortgage funds and property trusts-are also
available.

The diagram below illustrates some broad distinctions between
debt investments available to investors, including unlisted
debentures and unsecured notes, and listed corporate bonds.

This booklet looks at unlisted debentures and unsecured notes.
This is where investors lend money to a company, which issues a
promise to repay that money to investors at a future date, as well
as interest.

The debentures and unsecured notes are 'unlisted' because they
are not quoted (or 'listed') and traded on a secondary market, in
the way that shares and corporate bonds, for example, are quoted on
the Australian Securities Exchange (ASX). Instead, you typically
deal directly with the company issuing the unlisted debentures and
unsecured notes when you enter or exit the investment.

Corporate bonds are a separate category of debt investment and
are generally listed investments. These are described in a separate
booklet, Investing in corporate bonds?

Know what the investment is

What is a 'debenture' or 'unsecured note'?

Debentures or unsecured notes are a way for businesses to raise
money from investors. In return for your money, the business (or
'issuer' of the debenture or unsecured note) promises to:

pay you interest

pay back the money you lend it (or your 'capital') at a future
date.

An investment can only be called a debenture in documents
relating to an offer if the security in place is over tangible
property of the issuer. Unsecured notes, on the other hand, are
generally riskier than unlisted debentures as there is no tangible
property provided as security for investors. ASIC will require all
businesses to follow this approach to the naming of debentures from
1 July 2011.

By investing in a debenture or unsecured note, you are lending
your money to a business, with all the risks that this
involves.

The issuer might use your money to finance a wide range of
business activities. It might also lend your money to another
business (known as 'on-lending').

Debentures and unsecured notes are 'fixed interest' investments.
This means that the interest rate on the money you lend is set in
advance. However, interest payments on your money and the return of
your capital are not certain.

A debenture or unsecured note is not the same as a term
deposit.

What is an 'unlisted' debenture or unsecured note?

An unlisted debenture or unsecured note is not listed on a
public market, such as the ASX.

There are differences between unlisted debentures and unsecured
notes and listed debt investments that can make it harder for
investors to know what's happening with their investment. These
differences include:

The issuer of an unlisted debenture or unsecured note is not
subject to stockmarket requirements to make information affecting
the price or value of the investment publicly available.

Unlisted debentures and unsecured notes are not listed on a
stockmarket where you can see the price of the investment (and
whether it is going up or down) and sell it if you want to.

It can be harder to get out of the investment early.

Trading in unlisted debentures or unsecured notes is not
subject to the ongoing market supervision of ASIC.

Do your research

Before you invest in a debenture or unsecured note, it's
important to understand the features and risks of the product.

A good place to start is the prospectus.

Why is the prospectus important?

The prospectus will tell you how the investment works, and you
should read it in full. However, if you read nothing else, make
sure you read the sections that:

explain the key features and risks of the investment

explain certain indicators or 'benchmarks' that can help you
assess the risks of unlisted debentures and unsecured notes (see
below).

You should find this information in the first few pages of the
prospectus.

The prospectus should tell you everything you need to know about
the issuer, what it will do with your money, and the terms of the
investment.

A prospectus must be lodged with ASIC before it can be used to
raise money from investors. However, this does not mean that ASIC
has in any way checked or endorsed the underlying investment.

Assess the risks

The return offered on an investment is not the only way to
assess how risky it is. ASIC has developed 8 benchmarks that apply
to unlisted debentures and unsecured notes to help you assess the
risks.

Issuers must tell you in their prospectuses how they meet each
benchmark. If they don't meet a particular benchmark, they must
explain why, allowing you to decide whether you're comfortable with
the explanation.

Here's how you can use ASIC's benchmarks to assess the risks in
unlisted debentures and unsecured notes:

Look for information about each benchmark in the
prospectus.

Review whether the issuer and/or investment meets the
benchmark.

If not, does the issuer say how and why it deals with this risk
in another way?

Decide if you're satisfied with how it deals with this
risk.

If you're not satisfied with how the risks are dealt with, are
you willing to risk your money in this investment?

Take your time and think things over before you invest. Get
professional financial advice if you're unsure what to do.

Remember: Benchmarks are not a guarantee that
an investment will perform well. Even if an investment meets all
the benchmarks, you could still lose some or all of your money if
things go wrong. The benchmarks are simply designed to help you
understand the risks and make a decision about whether to invest
your money.

The benchmarks are not a guarantee that an investment will
perform well.

Even if this investment meets all the benchmarks, you could
still lose some or all of your money if things go wrong.

Any investment should meet your goals and suit you.

ASIC does not endorse specific investment

Benchmarks 1-4 apply to all issuers of unlisted debentures and
unsecured notes

1. Equity captial

Equity capital means money the issuer has invested in the
business.

To meet this benchmark, the issuer must have the following
minimum equity capital:

Business activity

Equity capital

Property development

20%

All other types

8%

The issuer must also provide a comparative equity ratio from the
prior year, so that investors can see if it has changed.

What's at stake for you?

If the issuer has less equity capital invested in the business,
there might be no safety margin to tide things over if the business
runs into financial difficulties. It could also mean that the
issuer has less incentive to operate the business prudently and
responsibly because less of its own money is at risk.

2. Liquidity

Liquidity means the issuer's ability to meet short-term cash
needs.

To meet this benchmark, the issuer must:

estimate its cash needs for the next 3 months

ensure it has enough cash or other liquid assets to meet those
cash needs. Liquid assets are assets that can be readily converted
into cash

'stress test' its liquidity to see if it would have enough cash
or liquid assets if there was a 20% decrease in the issuer's
rollover or retention rates (see 'Rollovers' below).

What's at stake for you?

Liquidity is an important measure of the short-term financial
health of an issuer or business. An issuer that has insufficient
cash or liquid assets might be unable to meet its shortterm
obligations (e.g. to run the business properly, pay you interest,
or pay your money back at the end of the term).

3. Rollovers

Some investments are automatically rolled over at the end of the
investment term. This may mean that your money is re-invested for a
similar term unless you withdraw it.

To meet this benchmark, the issuer must clearly state in the
prospectus what happens at the end of the investment term,
including how it will update you with new information since you
last invested.

What's at stake for you?

Make sure you keep up-to-date with your investment. Things might
have changed-for both you and the issuer-since you first invested.
You might prefer to withdraw your money rather than simply rolling
it over for another term. Beware of notice periods that don't give
you much time to act.

4. Debt maturity

This refers to the size, timing and cost of the issuer's
borrowings. This information is important because it lets you know
what other borrowings and debts the issuer has, how much interest
it has to pay and when the loans will become due.

To meet this benchmark, the issuer should tell you:

when its debts and other borrowings will fall due, by term and
by value (the 'debt maturity profile'). This includes debentures
and unsecured notes on issue

about the interest rates, or average interest rates, applicable
to these debts and borrowings.

What's at stake for you?

The issuer's debt maturity profile is a useful gauge of looming
financial pressures. For example, an issuer that needs to repay a
large amount of debt within a few months may be riskier than an
issuer with a well-spaced repayment schedule. That's because the
first issuer may need to use a large amount of cash to repay the
debt, or to refinance it under pressure.

Benchmarks 5-6 apply to issuers that lend your money to someone
else

5. Loan diversity

Just as you can spread your own investments to manage risk, an
issuer can manage risk by spreading the money it lends between
different loans and different borrowers. This is called 'loan
diversity'.

To meet this benchmark, the issuer should tell you:

its policy on loan diversity

the maturity profile of its interest-bearing assets (e.g. its
loans and investments) and its lending, by term and by value

the interest rates, or average interest rates, applicable to
these assets and loans

how many loans it has by number and value including:

class of activity and geographic location

the proportion of loans that are greater than 30 days overdue,
or are renegotiated loans

the proportion of total loan money that is lent on a 'secured'
basis, and what the security is

the proportion of total loan money the issuer has lent to its
largest single borrower and 10 largest borrowers

the proportion of loans that are subject to legal proceedings
to recover debts.

What's at stake for you?

Is the issuer's loan portfolio heavily concentrated in a small
number of loans, or in loans to a small number of borrowers? If so,
there is a higher risk that a single negative event affecting one
loan will put the overall portfolio (and your money) at risk.

It is also important to know the proportion of loans in default
or arrears ('past due') and what the lender is doing to address
this.

6. Related parties

A 'related party transaction' is a transaction (e.g. a loan)
involving parties that have a close relationship with the
issuer.

To meet this benchmark, the issuer must tell you:

how many loans it has made to related parties and the value of
those loans, both in dollars and as a percentage of the issuer's
total assets

how it assesses and approves related party loans

about any policy it has regarding related party lending,
including matters such as interest rates, security and
loan-to-valuation ratios. ASIC expects that most issuers will have
a firm policy on how they lend funds.

What's at stake for you?

The risk with related party transactions is that they might not
be made with the same rigour and independence as transactions made
on an arm's length commercial basis. There is a greater risk of the
loans defaulting and therefore your money is at greater risk
if:

the issuer has a high number of loans to related parties

the assessment and approval process for these loans is not
independent.

7. Valuations

Knowing exactly what the issuer's underlying assets are worth
(i.e. accurate valuations) can help you assess its financial
position.

To meet this benchmark, the issuer must:

tell you how often it gets valuations done (and how recent a
valuation must be for a new loan)

establish a panel of valuers

ensure that no single valuer conducts more than one-third of
the valuation work

ensure that properties still being developed are revalued at
least every 12 months, unless the funds are released in stages

tell you about the valuation of a particular property if the
property is 5% or more of the issuer's total property assets, or if
the loan is 5% or more of its total loans

value property in the following way:

Type of asset

Basis for valuation

Property (development)

'As is' basis and 'As if complete' basis

Other property, e.g. real estate

'As is' basis

What's at stake for you?

If the issuer does not include information about valuations in
its prospectus, it will be more difficult for you to assess how
risky the investment is. Keeping valuations up-to-date and shared
among a panel means they are more likely to be accurate and
independent.

* For example, property-related activities
might include property development or mortgage financing.

8. Loan-to-valuation ratio
(LVR)

This benchmark applies to issuers that on-lend money for
propertyrelated activities. The LVR tells you how much of the value
of an asset is covered by a loan. The LVR is a key risk factor when
assessing whether to lend money to someone.

To meet this benchmark, the issuer must:

only on-lend money for property development in stages

maintain the following maximum LVR (based on a valuation
obtained under benchmark 7):

Business activity

Loan-to-valuation ratio

Property development

70% of the latest complying valuation

All other types

80% of the latest complying valuation

What's at stake for you?

A high LVR means that the investment is more vulnerable to
changing market conditions, such as a downturn in the property
market. Therefore, the risk of losing your money could be
higher.

Think about your own situation
and needs

Does the investment meet your goals?

Whenever you invest your money, it is important to have a
financial goal in mind, and a strategy for meeting that goal. For
example, your goal may be looking for a secure income for your
retirement. Think about getting professional advice from a licensed
financial adviser to help you develop a suitable investment
strategy according to the level of risk you're comfortable with.
Then measure all investments against that strategy.

Is it important to you to protect your capital?

Be careful about words like 'safe' and 'guaranteed' in
advertisements. They might imply that the investment is secure,
when in reality it is not.

Certain financial institutions like banks, building societies or
credit unions are specially regulated by the Australian Prudential
Regulation Authority (APRA) to make sure that, under all reasonable
circumstances, they can meet their financial promises to you.

This type of regulation, called 'prudential regulation',
protects you, for example, if you put your money in a term deposit
with one of these institutions.

The Australian Government has guaranteed deposits in Australian
owned banks, locally incorporated subsidiaries of foreign banks,
credit unions and building societies (institutions known as
'ADIs'). This means that this money is guaranteed if anything
happens to the ADI.

The government guarantee is automatic and free for deposits up
to $250,000 per person per ADI. If you have more than $250,000 with
one ADI then only up to $250,000 is guaranteed. Most issuers of
debentures and unsecured notes are not subject to prudential
regulation and do not have a government guarantee.

Have you spread your investments to manage risk?

Most people have heard the saying, 'Don't put all your eggs in
one basket'. When it comes to investing your money, a good way of
managing risk is to spread your money between different investment
types, such as cash, fixed interest, property and shares. The
spread will depend on your financial goals and how much risk you're
comfortable with. These different investment types are known as
'asset classes'.

Spreading your investments to manage risk is called
'diversification'. Just investing in debentures or unsecured notes
is not diversification.

By spreading your money both across different asset classes and
between different investments within the same asset class, you
reduce the risk of losing everything. By putting only a proportion
of your total funds into any one type of investment, you won't lose
everything if one investment produces poor results or fails
completely.

What returns are you being offered?

'High returns means high risk' is a familiar rule of thumb.
However, as with all rules, there are exceptions to look out
for.

Some investments that appear to offer relatively modest returns
can be extremely risky. That's why it's important to consider more
than just the returns when deciding whether to invest in
something.

When comparing rates of return, make sure you compare 'apples'
with 'apples' (i.e. similar investments).

Can you get your money back early?

What happens if you need to get your money out before the end of
the loan term? Is this an option and are there penalties for doing
so?

If you need flexibility, think about investing in other
financial products that allow you access to your money without
heavy fees or penalties.

Do you know how risky the investment is?

Debentures and unsecured notes are generally a riskier type of
investment than term deposits issued by banks, building societies
and credit unions that are prudentially regulated in Australia.

Ask yourself, is the return you are being offered high enough to
compensate you for the risk you are taking on by putting your money
in this investment?

Can you accept the risks?

The main risk with this type of investment is that the issuer
might be unable to pay you interest when it is due, or pay back
your money at the end of the term.

If you don't understand the risks in this investment or you're
not comfortable taking any risks with your money, look at other
financial products instead. Get professional financial advice if
you're unsure about an investment decision.

Do you know what you are investing in?

Check what the issuer plans to do with your money. This
information should be clearly set out in the prospectus, but don't
hesitate to ask questions until you really understand.

Knowing what your money will be used for can help you assess the
risks and decide whether you are comfortable with this
investment.

Is the investment related to property development?

If your money will be used for property development, consider
these extra risks:

Will the property development be completed on time and on
budget?

How is the property valued?

How will the issuer meet cash flow needs before the property
development is completed and sold?

The prospectus should help you to answer these questions.

People like to think that investing in property is 'safe as
houses'. In reality, it involves the same risk as any other
investment-the risk of losing as well as gaining money

Misleading
advertising? Hard sell?

Have you come across an advertisement for a financial product
that you think is misleading?

Or have you been pressured by a sales person to make a decision
when you didn't have enough information, or weren't sure that the
product was right for you?

Phone ASIC on 1300 300 630 to tell us about it. You can lodge a
formal complaint at www.moneysmart.gov.au. See
www.moneysmart.gov.au for some strategies to help you resist
pressure selling, so you don't end up investing in a financial
product that doesn't suit your needs.

For more information on what to look out for in general
investing, visit MoneySmart.